Geithner Allegations Beg Fed Reform

Allegations that Timothy Geithner, then head of the New York Federal Reserve, may have told banks ahead of time about a surprise policy move in 2007 underscores the pressing case for reform to safeguard the integrity and independence of the central bank.

Allegations that Timothy Geithner, then
head of the New York Federal Reserve, may have told banks ahead
of time about a surprise policy move in 2007 underscores the
pressing case for reform to safeguard the integrity and
independence of the central bank.

Specifically Congress needs to act to make the lines between
the banking industry and the governance of the regional Federal
Reserve banks cleaner, guarding against a "we are all boys in
this together" attitude and ensuring a diversity of views from
outside the financial services industry.

As revealed in transcripts released last week of Fed
meetings from 2007, Richmond Fed President Jeffrey Lacker said
Geithner, now the outgoing Secretary of the Treasury, discussed
with banks an upcoming change in the discount rate, a move which
proved highly price sensitive when it was publicly announced.

"From conversations I had prior to the video conference call
on August 16, 2007, I was aware of discussions among a few large
banks about borrowing from their discount windows to support the
asset backed commercial paper market," Lacker said in the
statement.

"My understanding was that President Geithner had discussed
a reduction in the discount rate with these banks in connection
with these initiatives." ()

Qualified banks can borrow from the Fed at the so-called
discount window at the discount rate.

The Treasury has declined to comment beyond the transcripts,
in which Geithner replied at the time about his discussions with
banks:

"The only thing I've done is to try to help them understand
- and I'm sure that's been true across the system - what the
scope of that is because these people generally don't use the
window and they don't really understand in some sense what it's
about."

Clearly a bit of sunlight is needed on this particular
episode, and doubtless some Congressional committee will take a
look at it. While the President of the New York Fed, which has
and should have deep links with banks and markets, will always
have need of discussions with bankers, tipping a rate move in
advance is highly improper, especially in times of financial
market dislocation.

Moreover, seeing as how Geithner, both at the Fed and as
Treasury Secretary, has seemed to consistently favor the
interests of banks over those of his many other constituents,
this is more than a little disturbing.

Geithner not only was instrumental in driving government
support for shaky banks, in words, pledges and through programs
like the Troubled Asset Relief Program, his management of
mortgage relief efforts was more effective for banks in
spreading out the pain of defaults than in aiding homeowners.

TANGLED LINES

Regardless of who did what to whom, there is a clear and
easy opportunity to put the regional Federal Reserve banks on a
more sound footing in their relations with the industry they
must help to regulate.

As it stands, six of the nine directors on the boards of the
regional banks are appointed by member banks, with the other
three sometimes appointed from non-profits which can and often
do solicit funds from banks. ()

So-called class A directors are chosen by and represent
member banks. They are almost invariably working bankers. Class
B directors are chosen by member banks to represent the public,
a state of affairs which would never be tolerated in other areas
of public life. Class C directors are appointed by Fed Governors
to represent a range of other interests.

Seeing as how the boards perform many important functions,
including helping to select governors, this creates at the very
least the appearance of undue influence, undermining essential
confidence in the independence of the system.

As a result of this state of affairs, Jamie Dimon, CEO of
J.P Morgan, was until the turn of the year a class A director of
the New York Fed, including during the time in which the central
bank was monitoring JPM's disastrous "London Whale" trading
escapade.

Dimon left at the expiration of his term and his seat is
still unfilled. He resisted calls for him to step down early,
and indeed was supported in doing so by NY Fed Board chairman
class C board member Lee Bollinger, President of Columbia
University, which has been financially supported by, yes, JP
Morgan.

This prompted a variety of calls for reform, notably from
MIT economist Simon Johnson, who argued that the boards should
be made strictly advisory. This was justified at the time, and
makes even more sense now. ()

Everyone involved may be behaving entirely ethically; it is
of course impossible to determine from outside. This is why the
situation cries out for reform.

Change the law so that Class B directors are appointed by
the Fed itself with an eye towards bringing in a diversity of
views on the economy. And make sure that Class C directors are
not in any way dependent on the good graces of banks in their
day jobs.

An independent Federal Reserve, accountable to the public at
large and carrying their confidence, is a great thing and too
valuable to risk.